Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Manufacturing Planning and Control

MPC 6th Edition

Chapter 11

11-2

Order Point Inventory Control Methods

Order point methods are used to determine appropriate order quantities and timing for individual independent-demand product items that are characterized by random customer demand.

Performed well, these inventory management functions can provide appropriate levels of customer service without excess levels of inventory and/or cost.

11-3

Agenda–Order Point Inventory Control Methods

11-4

Basic Concepts

Inventory supports both independent- and dependent-demand itemsIndependent-demand inventories–primarily

influenced by factors outside of company decisions (e.g. random variation)

• Demand forecasts estimate the average usage rate and pattern of variation

Dependent-demand inventories–influenced mainly by internal factors within the firm’s control

11-5

11-6

Inventory Management Issues

Routine inventory decisions–how much to order and when to orderInventory control decision rules can simplify

these decisions

11-7

Inventory Management Issues

Determining Inventory System PerformanceInventory turnover (annual sales divided by

average inventory investment)Fill rate (percentage of units available when

requested by customers) Allows comparison of different systems and

evaluation of system changes

11-8

Inventory Management Issues

Implementing Changes in Managing Inventory–making the appropriate changes at the right time is critical

More formalized change management system is required as the scope of the business increases

11-9

Inventory-Related Costs

Incremental costs–does the cost represent an actual expenditure or lost profit? Does the cost actually vary with the decision being made?

11-10

Economic Order Quantity (EOQ) Model

Describes the relationship between cost of ordering, cost of carrying inventory, and the order quantity

HP CQ

CQ

ATAC )

2()(

Total Costs

Ordering CostsInventory Holding Costs

11-11

Determining the EOQ–Graphical Method

A = 1,250Cp = 6.25CH = 25TAC=(1,250/Q)6.25+(Q/2)25

TAC curve shows clear minimum value at Q=25

11-12

Determining the EOQ–Deriving the EOQ Formula

Derivative of TAC with respect to Q

Set derivative equal to zero and solve for Q

Economic time between orders (TBO)

D

EOQTBO

11-13

Order Timing Decisions

Q,R ruleWhen stock reaches predetermined inventory

level (R), a fixed quantity (Q) is orderedOrder point is influenced by demand rate,

replenishment lead time, uncertainty of demand rate and replenishment lead time, and acceptable level of customer service

Safety stock is the difference between average demand during lead time and the reorder point

11-14

Safety Stock in a Q,R system

S

R

Inve

ntor

y le

vel

TimeLead time

Order quantity (Q)Reorder point

Safety stock

11-15

Determining the Safety Stock in a Q,R system

Stockout probability–specify an acceptable risk of stocking out during any given replenishment cycleCarry stock sufficient to satisfy expected

demand with this probability Customer service level–define an acceptable

level of customer service (percent of demand met from inventory)

11-16

Stockout ProbabilityWith a lead time of one day, 95% of cycles will experience demand for 7 or fewer units

Sum of demand probability is 0.05 (5%)

Safety stock of 7 units will provide 5% chance of stockout during a one day lead time

11-17

Customer Service Level

Sum = 0.35

A reorder point of 5 units has a 35% chance of stockout, with an average of 0.56 units short each cycle

11-18

Safety Stock with Continuous Distributions

Reorder point Probability of at least one stockout during cycle

Expected number of stockouts per cycle

11-19

Probability of Stocking Out

Safety stock = Zσd

Reorder point = mean demand during replenishment lead time + Zσd

Z = appropriate value from standard normal tableσd = standard deviation of demand during replenishment lead time

Probability of demand between 3.5 and 6.5 units is 0.6827. Probability of stockout when safety stock is 1 unit is 0.3173 (1 – 0.6827)

11-20

Customer Service Criterion

Find the calculated E(Z) in the chart to determine the Z value

Calculate E(Z) using the desired service level (SL) and reorder quantity (Q)

Safety stock = Zσd

11-21

Time Period Correction Factor

Variations in demand and lead time complicate the calculations

When standard deviation of demand is measured over a different time period than the lead time, correction is required

perioddemand

timeleadm

mZStockSafety

m

D

Dd

When both demand and lead time vary, additional adjustments are required

periodsintimeleadaverageL

periodperdemandaverageD

DL LDd

22

2

11-22

Forecast Error Distribution

Safety stock can be based on forecast error rather than historical demand variation

Standard deviation = 1.25 MADMAD – mean absolution deviation

11-23

Multi-Item Management

Management attention should be focused on the most important items

ABC analysis segments the inventoried items according to annual cost volume usage(unit cost x annual usage)

A items are the most importantThis small percentage of items usually makes

up a majority of annual cost volume usage B and C items are progressively less critical

11-24

Principles

The difference between dependent and independent demand must serve as the first basis for determining appropriate inventory management procedures.

Organizational criteria must be clearly established before we set safety stock levels and measure performance.

A sound basic independent demand system must be in place before attempting to implement advanced techniques.

11-25

Savings in inventory-related costs can be achieved by a joint determination of the order point and order quantity parameters.

All criteria should be taken into account in classifying inventory items for management priorities.

The functions of inventory are useful principles to apply in determining whether or not inventory reductions can be made.

Principles

11-26

Quiz – Chapter 11

Order point methods are generally used for _____________ demand items.

Cycle stock is are a result of manufacturing lot sizes? (True/False)

Stock produced for upcoming promotional events would be considered _______________ stock.

The two main decisions when managing independent demand items are _______________ and ______________.

A measurement that relates inventory levels to product sales volume is ___________ _____________.

The three types of costs associated with holding inventory are ____________, ______________, and ____________.